Session by Mr. Vinod Sethi at Value Investing Pioneers Summit(VIPS), New Delhi-2019

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Contributed By- Jyoti Soni, CFA

The last  session at the third Value Investing Pioneers Summit was conducted as a tête-à-tête between Mr. Vinod Sethi, ex. MD and CIO of Morgan Stanley India and Mr. Durgesh Shah of Flame Investment Lab.

This was a unique session in a sense that the speaker did not give a presentation. Instead a presentation was prepared by moderator Mr. Durgesh Shah on investment journey of Mr. Sethi. Mr. Shah quizzed Mr. Sethi about his investments, philosophy behind making those investments, investing mistakes, his gurus in the market, experiences which affected his personal and professional behavior etc.

Mr. Durgesh Shah introduced Mr Sethi as an unusual visionary investor and a multi-faceted person. Mr. Sethi did his graduation from IIT Mumbai and his MBA from Stern University with a scholarship. In the 1980s, Mr. Sethi was one of the youngest fund managers when he started working with Morgan Stanley.  Currently, he is  chairman of KCP Sugar and manages his own investments.

In his stint as an investor, he bought anywhere between 5-15% of stock in companies like Infosys, Hero Honda, Hinduja, Concor, Tata Motor etc. when no one was interested to touch these stocks. He has a terrific record of accomplishments in his investing career with his multidisciplinary thought process.

He worked in Morgan Stanley as a Managing Partner till late eighties. He had a fabulous career and splendid performance as money manager at Morgan Stanley. He treated Morgan Stanley as a training platform and learned a lot. After finishing the most exhaustive part of his career stint, he decided to leave Morgan Stanley in order to discover other facets of his life. Valuations of Morgan Stanley at that time aided to his decision as the share was trading at six times its book value and he monetized his ESOPs at the right time. He was the largest private sector fund manager when he left his job at Morgan Stanley in his 30’s.

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His investment decision making and lifestyle was influenced by three mentors in his early career. Lessons learnt from these mentors/investors helped him to become a well alert and humble human being, great analyst and money manager.

  • Michael Milken, the junk bond king of 1980s
  • Barton Biggs, chief of Morgan Stanley till 2008
  • Julian Robertson, known as a tiger, a client and shareholder of Morgan Stanley.

Mr. Vinod Sethi has always had a knack for recognizing the great futuristic entrepreneurs. He believed in their ventures and missions before most others in the market. Mr. Shah specifically probed him about his investments in Infosys, Hero Honda and HDFC.

In early 1990’s, he made investment in Infosys when most of the fund managers were not able to realize the power of IT industry and software services exports. At a time when the focus was on hard assets on the balance sheet, this was a company which did not have much of the hard assets except few computers and furniture with rented office building. Infosys valuation jumped to 5 times within a short span of two years of his investment.  His high conviction in prospects of Infosys was on display when he made another big investment in a preferential issue of Infosys which came after 2 years at a price 5 times higher than his initial investment.

Other unconventional example of his investment style was a motorcycle company, Hero Honda, when scooters were ruling two-wheeler space and motorcycle was not a preferred two-wheeler. Hero Honda was started by Mr. Brijmohan Munjal when he was in his late 60’s. Wherever Honda was selling its product in the world, they had around 15% market share at that time. Hero Honda was available cheap at that time as people thought motorcycles don’t have a future.

Mr. Sethi shared an interesting story as to how he came to know about HDFC. One analyst came to his office with one-page summary of many companies and one of them was HDFC. That time HDFC was trading at 1 or 2 times earning and no one seemed to like it. His thinking behind investing in HDFC was that the country is homeless, and mortgages as a business will pick up.

His acumen to understand the future trends in an industry and high conviction in his ideas resulted in building of an exceptional portfolio.  He never thought that these companies would become so big and neither did the owners/promoters of these companies, but he was sure of making decent returns.

He never believed in the idea of investing in traditional investment assets like gold and real estate. He believes that what is the point of investing in an asset class where your returns are lower than your cost of borrowing.

Mr. Sethi believes that formal education is a necessity but not sufficient. He believes that education doesn’t teach you about hunger, relationship, courage, inner voice – listening to yourself, feel the present moment and many other aspects. There are many other aspects and skills which one requires in investing business and daily life. “While a degree certainly helps, it is no insurance policy. it might get you through the door, but you have a whole life to face. One can be rendered irrelevant if he or she doesn’t keep himself or herself up to date”, he says.

Mr Sethireads at least one annual report a day. He might read an annual report of a private company in Europe where he won’t be even able to invest. According to him, an annual report is a summary of collective human effort. Hence, it shouldn’t matter what annual report you are reading. One makes money where one sees financial efficiency, an alchemy or something stands out. There is no need to read an annual report to the last line. Over time one can develop sense as to what to read and what not to read. Also, according to him, speed reading helps.

Mr. Sethi likes to keep half a day of his schedule open to meet people. He is not focused on meeting business people alone; he will meet any one from any field. Meeting people is not about cocktail party or dinner party and just floating around . Having a focused conversation really helps and expands one’s horizon. Only way to meet very smart people is by making yourself very smart. No one would give you time unless you give more than they gave you. If you start every meeting thinking I must give more than what I am expected to gain, then you achieve a very high level of evolution at personal level.You make the world a better place and give someone food for thought. Additionally, he stated that three things are a must do for a good investor:

  1. Pay attention to the Market: He emphasized on deep understanding of market phenomenon.
  2. Read & Research: He opined that speedy and attentive reading is necessary for a money manager. One should read an annual report daily and should take not more than 30 minutes for this. Quick and accurate analysis of company’s financials and performance is key to taking the right decision.
  3. Introspection: One should give time to oneself for self-discovery. One should understand one’s strengths & weaknesses, passion and priorities in life.

When the attack of 26/11 happened, Mr. Sethi was present at the Taj Hotel. He realized during the attack that what we call fear and nervousness, we can only afford that in a movie theatre. In real life, that is not an option. In such situations, you either stay rational and come out of it or get knocked up. Another thing he learnt during this experience is remarkable ability of human beings to survive.

He believes that investing is a combination of teamwork and individual efforts. Basically, it is a lone ranger game but having like-minded people who share and discuss ideas can really help.  .

Mr. Sethi, then, went on to answer a few questions from audience before ending the session.

Link to the complete presentation- Vinod Sethi – 08.11.2019

 

 

 

 

 

 

 

 

 

 

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“Some thoughts on Investing” by Mr. Prashant Jain at 3rd Value Investing Pioneers Summit(VIPS),New Delhi-2019

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Speaker: Prashant Jain, CIO, HDFC AMC

Moderator: Rajeev Thakkar, CIO & Director, PPFAS Mutual Funds

Contributed by : Udai Cheema

Star-studded event with a high impact factor!

Last year, I had attended the 2nd Value Investing Pioneers Summit. That event was quite a learning experience for me, so when the opportunity presented itself again this November, I was there. After all, who can resist this line up of speakers, take a look-

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We are talking about 100+ years of cumulative market experience along with assets under management worth billions of dollars. So, not wanting to miss out on such a golden opportunity, hundreds of participants thronged the halls of Hotel Pullman, Delhi Aerocity on the 8th of  November 2019 for the 3rd Value Investing Pioneers Summit.

Here are some of  the key takeaways from the first session of the conference –

  • Regardless of many gloom and doom scenarios locally or globally over the last four decades, India has maintained a nearly constant nominal GDP growth. He gave a great analogy to explain the importance of that fact-“We are sitting in a boat that is in a river flowing at a steady speed and if we don’t mess up then the river itself will create significant wealth for us”.

 

  • First time in the history of India, the inflation rates have stayed at the level of 4-5% over a prolonged period of nearly 5 years. If this is an indicator of things to come then we might have to lower our expectations of market returns going ahead.

 

  • Most of the economic parameters are currently in India’s favor such as inflation, current account deficit, foreign exchange reserves, interest rates but ironically the growth has slowed down sharply due to lower discretionary consumption.

 

  • The main reason for the consumption slowdown in his opinion is that the white-collar wages in India have de-grown in real terms and over the years there has been a convergence in the average wage of white-collar and blue-collar jobs in India. As a result, the financial savings rate in India has also fallen for the first time in the last ten years. A big chunk of the consumption that has happened in the last couple of years has actually been debt-fueled consumption on the back of EMIs. There is a limit to how much borrowing a society can do, that limit might have been reached in India causing the overall slowdown in the economy.

 

  • In fact, in the 80s India’s per capita income was higher than China but now it is 5 times more than ours. Same is true for wages, wages in China are much higher than those in India. On the other hand, this along with factors such as US-China trade wars and environmental concerns in China have also led to the shifting of global manufacturing base from China to other Southeast Asian countries such as Vietnam, Thailand, Indonesia whereas India was missing out due to higher corporate tax rates but going forward that is no longer a worry as the government has cut corporate tax rates bringing them at par with global averages. A massive domestic market and ample workforce give India an added advantage over these countries.

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In his view, the next capex cycle in India will not be led by the local companies rather it’ll be the global companies that will start the next capex cycle in India. Considering they will enjoy further concessions on corporate tax rate if they commence operations in the next 3 years, it is highly likely that revival in capex is not far. This will lead to the growth rates in India coming back over time.

 

  • India’s market cap to GDP ratio indicates that there is good value in the market at present. When earning yields converge with bond yields, it means one is paying very little for growth which is the present scenario. With the cost of capital/interest rates moving lower, it will have a positive impact on the earnings going ahead improving yields.

 

  • Simply if we remove some of the consumption-oriented stocks from the equation, there is a lot of value in the markets currently. The forward PE of the index which is roughly 15 times can fall anywhere between 20-30% if we are to remove these names. Consumer staples being traded at 50-100 times is unheard of and more so abroad. Even though the markets continue to defy the logic of value but in the past, all excesses, be it 1992, 2000, 2008 or 2017 were curtailed eventually. Also, remember that whenever the markets are over focused on one area it creates lots of opportunities (value) in other areas, it’s just that long term thinking is required along with patience.

“Keep things simple, one doesn’t always have to write a 100-page report to come to a conclusion. Simply apply the right logic and if you find no flaw in your logic then just stay put till the market eventually corrects itself.”

  • Instant gratification and desire to avoid pain are the two factors that contribute to the emergence of value buying opportunities in the markets. To illustrate this he used the famous example of the Marshmellow test.

 

  • Momentum is easy to participate in and difficult to stay away from because if one doesn’t then people appear to be earning today whereas you might not be which can be painful. Another tendency that supports momentum is that people simply extrapolate the present into the future which might not be the case. Instead one needs to understand why the business is doing well or badly over the last couple of years and where the business is headed from here on in.  So, buy cheap, increase your understanding of the business over time, keep modifying your views and in the long run, markets are likely to agree with you as they are quite efficient in the long term.

 

  • An interesting hack he mentioned to understand where the exuberance and pessimism stand at the moment is to look at the long term charts of the sectoral indices. On a yearly basis, they will clearly tell you which are the most loved and hated segments of the market. Understand that one cant simply extrapolate the peak earnings of a sector into the future, more so when the earnings have had a boost in recent times due to external ‘one-time’ factors.

“Mean reversion is true in life and in the markets. Both good and bad times shall pass.”

 

  • The discount of PSUs to the market as a whole has deepened quite sharply in recent times as there are some preconceived notions in the market for these public companies. PSUs are very predictable businesses and fairly easy to understand. PSUs are run under strict guidelines and investments in unrelated areas are quite infrequent. The mortality in the PSU space is much lower than in the private sector. In fact, PSUs in their particular sector are quite dominant franchises.

“Not all public sector is bad and not all private sector is good”

 

  • In fact, PSUs are a better paymaster than the private sector as on date which might not have been the case 15 years back.

“A major flaw in our thinking is that we tend to generalize by exceptions”

 

  • The media always highlights the outliers and not the averages. Rather than looking at the average salary of Virat Kohli, one should try to find out the average salary of an average cricketer for the purpose of generalization. The more people start working with averages, they are more likely to reach the right conclusions.

 

  • Amongst the PSUs, service-based companies like the ones in the telecom sector or the airlines’ sector are at a significant disadvantage but the resource-based, asset-based, trust-based companies have significant advantages and value. Simply the dividends in some of these companies are at par or even two times the bond yields at present. Also, the announcement of strategic divestments bodes well for this segment of companies.

 

  • Efforts must be made to try and seek out people who have contrary views on a particular idea. It helps challenge the confirmation bias. Documentation, presenting ideas to peers is a great exercise for building a strong investment thesis. One must listen to everyone, evaluate the merits of each argument but in the end make your own decisions as your money is your responsibility.

 

  • Information overload is a problem in modern times. Sifting through all that to reach the info/data that truly adds value has become increasingly difficult. So, work only on your high conviction ideas which according to you have the best chance of delivering superior returns rather than looking at everything.

 

  • Investing at an institutional level can never become fully process driven because in the same institution there will always be a duality of opinion that should be encouraged.

“Processes can lead to average outcomes with more certainty but great outcomes in this industry won’t be possible without great individuals.”

 

  • One doesn’t always have to be a contrarian while investing. It is all about understanding the business well, figuring out its fair value and how it will move i.e the key drivers and the risks associated with the business. If you prudently invest after figuring out all of that and it happens to be a contrarian call then so be it.

“There is a thin line between being early and being wrong.”

 

  • In such a scenario, simply go back and see why things have not played out the way you had anticipated. If you find a flaw in your assumptions/thesis then exit regardless of the price but if you still believe that buying the stock was the right call then have patience and simply wait it out before the market realizes its true value.

“If your conclusions are right then it has been frequently observed that the longer the pain period, higher are the rewards.”

 

  • There are very few companies that are exceptional in perpetuity. The companies’ termed as exceptional today weren’t viewed the same way 20-30 years back. So there should be a threshold below which investors must not go but one cant stay restricted to buying only exceptional companies. So one must take an objective and pragmatic view on quality and price.

“We are in the business of investment and not in the business of buying the best companies, we should aim to make good returns on our capital.”

 

  • How to identify a bubble;

“1.When everyone wants to buy the same stock. Consensus trades after a while tend to become a bubble both on the upside and downside but sometimes on the downside, they can turn into value bets.

2.Strong divergence from the past.

3. Think about what has led to the current situation.”

For example, in the consumption stocks, the earnings growth has not been superior compared to the past. The growth stands out because other sectors have hardly shown growth in comparison but on a standalone basis these consumption names have not grown earnings much but the margins have grown sharply. Most of these companies are sitting at lifetime high margins. So, if one was to break up the returns from topline growth and margin expansion, one will get the answer to the future as the margins can only grow so much and what are we paying at present for that.

“Simply try and understand what brought us here and is it sustainable.”

 

  • On the Auto Sector – not sure if the growth is coming back because cars face a challenge of affordability and the two-wheelers market in India has matured. Great value in the sector is not apparent.

 

  • High-interest rates are not the reason for the slowdown in growth. The mortgage rates today are much lower than what they were earlier, so the EMIs have dropped 20-30% but home sales and car sales which should have gone up aren’t doing so. This clearly suggests the issue of affordability as the gap between rental yields and mortgage yields is high in India making the EMI outgo much higher than the collectible rent. As there is a de-growth in the white-collar wages, the real estate has become unaffordable for many which has put the entire real estate sector in jeopardy.
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Session on “Learnings from My Investment Career” by Mr. Sankaran Naren at the 3rd Value Investing Pioneers Summit(VIPS), New Delhi, 2019

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Speaker: Mr. Sankaran Naren, ED & CIO at ICICI Prudential Mutual Fund

Moderator: Mr. G. Maran, Executive Director, Unifi Capital

Written by: Shagun Thukral, CFA

Mr. Sankaran Naren, CIO at ICICI Prudential Mutual Fund, spoke at the post lunch session at CFA Society India’s Value Investing Pioneers Summit in New Delhi.

Naren’s was an enlightening session as he spoke about his investment style, philosophy and  learnings  through the course of his long and illustrious career in the investment management. He covered a broad spectrum of topics ranging from essentials of investing, his contrarian style, understanding cycles, key metrics for stock picking, wealth creation and limitations of investing.

Naren started with the basics of investing which according to him comprised of – buying, sizing and selling. He made an astute observation – “if one was to look at available literature, 90% of it was focused on buying, when in reality more time should be spent on sizing as well as selling decisions”. He also shared a behavioural hack with the audience – since it is difficult to take a ‘sell’ decision, one should evaluate these decisions as a ‘switch’ – assuming one is always selling to buy something else. This makes it easier to take such decisions. Naren has often been associated with the Contrarian style of investing. He said that since he manages large portfolios, a contrarian style suits him well. Mutual funds get large amount of inflow in bull markets when other investors are shunning what is not popular. This gives him a chance to pick these investments at attractive prices and in large volumes.  According to him, contrarian investors should be careful on leverage as wrong timing in a leveraged contrarian trade can prove to be disastrous.

Naren said that contrarian investing works best in cyclical sectors (as these sectors are prone to mean reversion). He also emphasised on knowing the counterview on the stock, having a grip on the intrinsic value of the stock and doing appropriate risk management.

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Naren said that when it comes to investing, he believes in three things – Cycles, Charts and Common Sense.

He explained that markets go through cycles because of investors’ irrational behaviour. However, these cycles also give smart fund managers opportunities to buy and sell He also advocated the use of charts before a buy/sell decision for the primary purpose of understanding how many people have the same thought process, e.g. if many people are thinking like you, it may not be good trade as it would have already affected the price.

The next big learning shared by Mr. Naren was the importance of taking a cash call. Although cash is often considered a residual asset class, the importance of holding cash was highlighted during the 2007-09 period as the global financial crisis unfolded. Only those investors who had some cash could utilise the opportunity available and it helped them to recover quickly from the drawdown.He advised that if everything is expensive then invest in gold or cash. If everything is cheap, then keep nothing in cash.

Naren then moved on to discussing key metrics that he considers important while picking stocks. These included the trailing P/E, P/B, P/cash earnings ratios as well as market cap, balance sheet quality and IPO/QIP activity in the sector. Specifically, he felt that comparing the market capitalization of stocks, sectors etc had served him well in the past as it helped identify extremities in the market. He explained this with several examples.

In 2007, the market cap of DLF was greater than the entire pharma sector put together, indicating a clear sell in the stock in hindsight. In 1999, at the height of tech rally, the combined market capitalisation of Infosys and Wipro was 3x of combined market cap of some leading metals and cement companies. He even pointed out how currently (Sep ’19) market capitalisation of HUL was higher than combined market capitalisation of top 10 pharma companies in India.

For wealth creation, Naren follows the following framework (VCTS) : Valuation (the data)-Cycle (how others are behaving)-Trigger (the event)- Sentiment (the flows). Of these he believes that valuations are the easiest whereas identifying the trigger is the toughest (as these are not knowable and controllable). Ideally if the other three (VCS) are in place, one must act and not wait for the trigger.

Given his thought process and investment philosophy, Naren finds it difficult to buy high trailing P/E or high market cap stocks which at times leads him to miss growth sectors. He also tends to avoid stocks that have consensus among fund managers.

Naren then highlighted the key traits required in a person who wants to succeed in investing These include: 1) Time management 2) Thinking 3) Temperament 4) A habit of reading,

In conclusion, Mr. Naren shared some ‘truisms’ that budding investment managers may keep in mind. These were as follows:

  • Hubris is a reality – use hybrid funds, credit funds, close ended funds and avoid leverage to deal with this
  • No decision is also a decision
  • There will be mistakes and it is not possible to get all calls right
  • Money comes to a fund manager till he fails (Success leads to more inflows, which makes managing tougher and tougher till one fails)
  • Nothing called consistency in performance, only in processes
  • Forced buying or selling are good investment/disinvestment opportunities

The session was extremely well received and Naren went on to address several questions from participants as well. During the QnA , he stressed on the need to follow a transparent and responsible fund investing. He also advocated on being an ‘unemotional’ fund manager as it helps in taking key decisions like not giving buy calls all the time.The mutual fund industry is sometimes criticized on being over diversified but Naren cleared the air that diversification is a function of the size of fund one manages and the big mutual fund houses are bound to be well diversified. Lastly, the speaker opined that ” The challenge of investing is the ability to take a process and religiously follow it on a continuous basis”.

Link to complete presentation-S. Naren – Presentation

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Session by Mr. Utpal Sheth on “Megatrends and Leadership” at 3rd Value Investing Pioneers Summit(VIPS) , New Delhi 2019

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Speaker- Mr. Utpal Sheth, CEO of Rare Enterprises

Moderator- Prof. Sanjay Bakshi, Managing Partner, ValueQuest LLP

Contributed By : Parvez Abbaz, CFA

The Delhi Chapter of the CFA Society India successfully organized the Third Value Investing Pioneers Summit on Nov 08, 2019 at Hotel Pullman in Aerocity, New Delhi. The financial industry veterans addressed the jam packed gathering of seasoned and budding professionals, who came from all corners of the country. Those present at the conference had the privilege to listen to Mr. Utpal Sheth – CEO of Rare Enterprises and one of the most respected value investors in India – for the first time ever at a public forum. The topic of his presentation was ‘Megatrends and Leadership’. According to him, these two are the foremost determinants for value and wealth creation.

Mr. Sheth started the presentation by sharing his learnings from market history. There are sectors like consumer durables, cement, FMCG and private banks that have consistently outperformed broader indices over long-term due to structural changes or megatrends. Top 3 companies in these sectors (in terms of market cap) have constituted more than 50% of the market cap of the sector on a sustained basis. In fact, they kept rising inexorably over long-term (leadership). On an incremental basis, these companies created most value across sectors over many cycles. These formed the basis of his presentation.

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He then explained that megatrends are structural shifts that are longer term in nature and have irreversible consequences for the world around us. They transcend geographies, governments and generations. They throw new opportunities and threats and bring about new winners and losers. Some of the megatrends over time are:

  • IT revolution
  • Urbanization
  • Consumption boom
  • Women in the workforce
  • Digital transformation
  • Unorganized to organized sector shift
  • Demographic evolution

He further explained megatrends through the case study on Indian IT sector. The change in the management thought process to focus on core competencies led to evaluating the possibility of outsourcing. This led to plethora of offshoring opportunities and the opening of offshoring delivery centres. The decline in network and storage costs further provided impetus to the IT sector. IT budget as a % of revenue across sectors has remained in the 1% to 6% range. Indian IT market share in global IT services spend rose from 2.2% in FY04 to 13.0% in FY19. Indian IT successfully broke into newer verticals like Healthcare, Energy & Utility and Hospitality besides BFSI, manufacturing and telecom. Offshoring kept on increasing and accounts for roughly 70% of total revenue of Indian IT giants like TCS and Infosys. Mr. Sheth took data for the past 10 years to depict how TCS and Infosys have managed high ROCE consistently. The top 4 Indian IT companies’ revenue growth has remained higher than the global GDP growth in the last decade. He explained how the IT giants managed to achieve these because of excellent leadership, continuous innovation and scalability.

Mr. Sheth emphasized that leadership attributes are both qualitative as well quantitative. He gave examples of quantitative attributes of leadership like market share (Asian Paints), least cost player (Shree Cements), share in cash flows (Maruti Suzuki), elongating competitive advantage position (D-Mart), leadership in durability (Nestle) and leadership in new segments (HDFC Bank). Some of the examples of qualitative leadership attributes are culture (Titan), innovation (Nestle), embracing disruption (Info Edge), redefining competition (HUL).

To value megatrends and leadership, it is important to value intangibles. The intersection of megatrends and leadership is a multi-sigma event and valuation metrics cannot reflect this outlier event appropriately.

He then advised on the portfolio management for megatrends and leadership. One should focus on 3-4 megatrends with high conviction. In each megatrend, focus on 2-3 players with leadership attributes. From the above list, classify them as clear leaders (major component of the portfolio), near leaders (inspirational component) and emerging leaders (high-risk component).

In his closing remark, he explained the approach of megatrends and leadership through the concept of gorilla investing. There are many monkeys in a jungle but few gorillas. Gorillas have double the lifespan of monkeys and are not challenged by them. One has to find the right animal (leadership) in the right jungle (megatrend).

The Q&A session was moderated by Prof. Sanjay Bakshi, Managing Partner, ValueQuest LLP. The questions revolved around identification of megatrends and leaders. What is perceived as a megatrend in one country may or may not get replicated in other countries. On being asked if government policies play a role, he said that they might accelerate or decelerate the shift in the short-term but not in the long-term. For budding professionals with limited capital, Mr. Sheth advised that there is no harm in starting small. There is no set formula and one is bound to make mistakes but it is important to learn from those mistakes and not repeat them.

Link to complete presentation- CFA Society – Megatrends and Leadership – November 2019 – Delhi

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Round Table on Fixed Income : Renewable Energy Assets Backed Bonds

Presented by: 1)Ms. Shreetama Ghosh  and  2)Mr. Jayen Shah CFA

Moderated by: Biharilal Deora, CFA

Contributed by: Sandeep Bhattacharya, Climate Bonds Initiative

Background and context: –

The CFA Society India recently conducted a roundtable on bonds backed by renewable energy assets. The roundtable, attended by members and industry analysts, focused on the opportunities and challenges of this niche but highly important sector. This article gives an account of the discussions that transpired at the roundtable. It has been written by Sandeep Bhattacharya of Climate Bonds Initiative.

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Background

It is estimated that, India requires US$ 1.8 trillion of additional investments by 2030 to mitigate the effects of climate change and also cater to the adaptation needs. In order to achieve the Nationally Determined Contributions (NDC) targets as agreed in the Paris accord, and ensure timely responsiveness to systemic risks of climate change, the conventional assets in the financial sector needs to be supplemented, and policies to help support the same are emerging.

Action taken by the Government

A part of the NDCs are commitments on clean energy, an area where the government has an ambitious target for deployment: 175GW of Renewable Energy (RE) installation by 2022 and 450 GW by 2030. Taken in context, India’s total generation capacity from all sources is about 360 GW currently. A strong institutional framework in the power sector has been used to roll out RE capacity through auctions.

Financing & refinancing of the RE assets 

RE deployment by private sector developers is currently funded largely by borrowing from banks and non-bank financial institutions. The IPPs’ (Independent Power Producers) receipts from PPAs (Power Purchase Agreements) are fairly fixed (varying with output) and low-risk, (though there are persistent delays by state utilities paying for their purchases) and are well suited to refinancing through a fixed income instrument like bonds.

Thus once the project is commissioned and is operating successfully, banks may refinance the loans through issuing bonds. Bigger developers, such as Renew Power, Greenko, Azure Power, CLP India and Hero Future Energies have directly accessed the debt capital market themselves.

Bonds have been issued both onshore and offshore – the latter accounting for the bulk of issuances so far. Presence of “dedicated green capital”, i.e. capital which can be invested only in environment friendly projects in the west attracted a lot of issuers, which acted as a clear incentive to label the bonds as “green”.

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Round table discussion on “Bonds Backed by Renewable Energy Assets”

In this context, CFA Society India conducted a roundtable on “Bonds Backed by Renewable Energy”, and the description of the event is as follows.

The session started with Biharilal Deora, CFA, Director CFA Society India, laying down some questions which are likely to be answered in the session and encouraged the participants to be interactive. The questions to be answered were as follows: –

  • How much of project risk does a RE project have compared to traditional power projects?
  • What will be the impact of the recently announced target of 450 GW?
  • How much of this can be financed by local capital?
  • Are NBFCs too exposed to RE?

The first part of the briefing session started with Ms. Shreetama Ghosh Chief Manager, Credit – Power at L&T Infrastructure Finance Co. Ltd, briefing about credit evaluation as seen at L& T Infrastructure Finance.

The brief from Shreetama dwelt on the following aspects: –

At L&T Infrastructure Finance, the major heads in evaluating risks for energy projects are

  1. Sponsor Risk
  2. Fuel supply risk
  3. PPA – There needs to be a PPA signed upfront
  4. Financing and cash flow risks

While solar module costs have been going down, the electricity costs have been going down much faster, and part of it can be explained due to the fact that returns on equity are also going down.

The solar modules are supposed to last for 25 years, and a test of the same needs to be done. L&T Infrastructure finance gets the testing done by DNVGL or Mahindra Susten.

Another feature which is a must for L&T Infrastructure Finance is a ring-fenced trust and retention account for the project. This isolates the project from other projects of the same promoter.

In addition, there are risks specific to the state where a project is located. In some states, the per unit cost of RE may be high due to some old projects. Such states may want to re- negotiate PPAs at a lower rate.

Expenses of RE projects –  The operation and maintenance is outsourced by means of a fixed price contract and thus, those expenses are fixed.

Post the brief from Shreetama, the session became interactive, with queries on financing needs of the 450MW RE targets; possibility of operating lease for RE; the risk and opportunities of corporates in-sourcing their consumption of RE through captive power plants; distributed RE assets; typical profitability levels and the current situation in wind power.

This was followed by a brief from Jayen Shah CFA

 Jayen touched upon the following:

Debt funding of projects has largely come from domestic investors, whereas major international players have been active in equity.

Many sovereign wealth funds, multilateral Development Banks like IFC, and global pension funds have stakes in a few of the IPPs. Some examples of such IPPs are Greenko, Renew Power, Azure Power etc. CDC has promoted an IPP, exited and then re-entered the segment by backing Ayana Power. Given this play, a lot of companies started with the intention of being in this field for the short to medium term.  Their motto seems to have been “let us start and someone will buy out”. There has been notable consolidation in the field – some players who exited include Kiran Energy, bought out by Hinduja Power; and Welspun Renewable Energy Pvt. Ltd, bought out by Tata Power. Renew Power too has grown by buying out a few IPPs.

In the bond market, CLP India was one of the earliest IPPs to issue a green bond.  This was the first corporate green bond to come to the market, and was issued in September 2015. In addition, Tata Power have issued bonds to fund their RE operations.

IIFCL came up with a first loss default guarantee product in 2010.  The first transaction, involving assets of Renew Power, happened in 2015   This had a 28% first loss guarantee and uplifted the credit rating of the instrument from A or A- as warranted by the assets, to AA+( SO). The tenor was extended to 17 years.

In terms of investor appetite, insurance companies and exempted provident funds participated. The Employees provident fund organization however did not participate.

This transaction as a market educator. There have been 3- 4 deals which have happened since. These transactions have survived some of the stress scenarios of delay of payments by DISCOMS.

The issuance of green bonds has been a lot more active in the offshore markets, where investors have been lured by the benefits diversification offered by dedicated green capital, apart from cost efficiencies.

Major offshore issuers have been IPPs like Greenko, Renew Power, Azure Power, etc. together with institutions like EXIM Bank, SBI, REC, PFC, NTPC, IRFC and IREDA (both NTPC and IREDA issued a Green Masala Bond).

Besides the issuance of green bonds, there were discussions around several other topics.  These included the relevance of carbon credits, the presence of “dedicated green funds” in the offshore markets and their consolidation, institutions with appetite for term debt for RE projects etc.

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Session on “Practitioner’s Session on Venture Capital- Understanding Fund Raising for Technology/ IT Companies” by Mr. Vipin Agarwal

Contributed By: Vidusi Saraf

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In today’s pecuniary setup, Venture Capitalists give hope to entrepreneurs to believe in their ideas and create value.  To throw light on intricacies of fund raising; functionality and psychic of venture capitalists, Mr. Vipin Agarwal addressed a curious gathering at Holiday Inn, Aerocity on 19th October 2019. Key highlights of the session are as below-

Part 1: From the past decade that went by

The tone of the session was set around deal making and investor types. To start with, Vipin talked about VC investments in Tech in the last decade.

During the era of “India Shine” in 2004, financial institutions in India led the VC investments in India. The earliest bets in private equity were taken in technology and infrastructure – logistics, power, real estate, telecom etc. This era closed with Reliance Power IPO in 2008 which was also the time for the global slowdown.

Next phase of upsurge came in after UPA took charge of their second term in 2009. “India Digitizing” saw the rise of e-commerce culture in the country. With names like Snapdeal, Flipkart, Jabong etc., classic VC deal making embarked the stage. Around that time, more than 50 investments were done in this space which started to consolidate in 2013.

2014 saw a sudden change in landscape with “Mobile Hopes.” Lot of global players entered this sector which led to drastic fall in mobile prices. Multiple round of funding was followed by a quick round of consolidation in 2016, leading to another downcycle.

Concluding the first part of the session, Vipin presented the “Bharat Arriving” theme popular in the VC community across the country today. It’s a period nursing Indianisation of investments with focus on tier 2 and tier 3 cities. He believes that India follows the Chinese way of building a business ecosystem, that 3-4 year cyclical trend in VC industry followed by a period of stillness has been in tandem with global giants like US and China.

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Part 2: How to identify the investor?

One of the explanations for fading rounds of funding for a start-up is conflict of interest amid the founders and investors. Vipin emphasizes on the fact that “Investor wishes should always match start-up’s aspirations”. How the investor examines the business of the entrepreneur plays an imperative role in making an entrepreneur strike the deal.

To throw more light on this, he divided the type of investors in 4 broad categories based on their venture outlook:

  1. Are you targeting a billion users?

This category comprises of those who solely look at the massive opportunities in the market, at how distinctive an idea is, at the expanse of people who will use the technology. Likes of investors in players like Facebook, Twitter and other B2C type products. Investors of this group are risk lovers and have the potential to go all-in at the very beginning, if they see the potential. They are not so moved by revenue and profit numbers but, rather by the quantum of audience targeted. 

  1. Where’s the money, honey?

They are the ones who make decisions based on critical analysis of the business model, revenue drivers, profitability metrics and other such variables. They love B2B technologies, and B2C with clear monetization. Unlike type 1 investors, they will only come in when the revenue drivers are in place. In such cases, multiple rounds of funding with the same investor is more likely. These late stage investors, are reasonably more challenging to deal with. 

  1. Did you disrupt anything?

These investors have, in most cases, tasted the flavour of entrepreneurship earlier and are now sitting on the other side of the table. They are always on the look out for innovative technology – newer ways of disrupting the conventional practices. Their razor-sharp focus is on the product idea. Unlike type 1 investors, they will only come in when the revenue drivers are in place. Hey are often negligent about monetization. Investors in this group, will bring in their own capital and pitch the product further to their network of investors. They are equipped to provide a support system if they are swayed by the idea.

  1. Change the world, please!

It’s an emerging group of investors whose idea is to make a social impact yet also earn money. This interesting dynamic is yet to be established and explored in our country. The amalgamation of an idea which brings a positive change in the society with a sound profitability model is challenging. There are some case studies which can be the stimulus to delve into the space.

Part 3 – How to value a company?

The last part of the presentation dealt with striking a deal with the investor. The ultimate goal of an entrepreneur is to persuade the party on the other side of the table to accept the offer. To be able to do this, an entrepreneur needs to understand the psychic of the investor and their style of investing. Entrepreneur should be able gauge what attracted him the most and the category (discussed above) he falls in from the first few conversations. The idea is to determine the KPIs that the investor is looking for in your company.

However, while presenting a case; using jargons, name throwing, ample charts and terms are certain details that Vipin recommended entrepreneurs should be wary of.

Largely, the session focussed on various behavioural and fundamental factors that an entrepreneur needs to contemplate upon during the deal making process. Certainly, emotional elements are as vital as the financials in a deal making process.

Link to session ppt –CFA-Lecture-Vipin-Agarwal-Oct-2019

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Session on Ranking Business Models by Ashish Kila

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Contributed by : Vaibhav Jain, CFA

CFA Society India, Mumbai Chapter hosted Ashish Kila on Thursday, 10th October. Ashish shared his thoughts on “Ranking of Business Model framework to select and allocate to great businesses”. Key takeaways of the session are as follows:

He presented the 4 C’s of investing – Cloning, Checklist, Capital Allocation and Checkout and elaborated on each one of them

  • Cloning – creating a universe of business to then further study. He suggested reading and following the domestic and global legendary investors and see the current themes going around globally, like QSR, food delivery, staffing
  • Checklist – selection of a stock based on 5 essential qualities (in the order of preference). All criteria need to be satisfied
    • Management
    • Longevity
    • No structural headwind / long term tailwind
    • Scalability
    • Favorable industry structure
  • Capital Allocation – Select on the basis of upside (using checklist) and then size them on the potential downside. Position sizing is the primary driver of portfolio returns. For this, he focused on 6 desirables
    • Valuation
    • Annuity
    • Switching cost
    • Optionality
    • Side Car Investing
    • Ability to capture dominant market share
  • Checkout

Ashish made the session extremely interesting by giving various examples in Indian context with each of the above points. He made a framework of ranking businesses on X-Y chart where X-axis showed Annuity and Y-axis for Switching cost.

The session ended with few questions from the participants and followed by the networking dinner.

VJ

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